3.15 Trading with Pennants

A pennant is a typical consolidation pattern and looks like a pointed flag.

A pennant is usually seen after a decisive up or down move, and is an area where the market is taking a breather, or consolidating.

Prices progressively make smaller moves between a pair of lines converging towards each other. The pattern is formed by prices rallying upwards from the lower support line and reacting downwards from the upper resistance line. Prices finally break out from the pennant near its apex or point.

Volume is highest at the initial, widest end of the pennant and diminishes gradually as the market moves towards the apex. Volume again increases when the price breaks out of the pattern. Pennants may be either bearish or bullish pennants.

Trading with Bullish Pennant Breakout

A bullish pennant is formed during a steep up trend, and is an area where the bulls are resting before mounting a fresh assault. As in the bearish pennant we see an inter-play between bulls that are booking profit and bulls entering afresh, anticipating a new up move. Once the eager and fresh bulls are able to absorb the selling from the bulls cashing out, they quickly look for sellers at higher prices, causing a break out from the pattern.

Lokking at the above chart you may find a lack of the uptrend before the pennant pattern formed. Let's look at the extended chart as follows:

The extent of the move after the break out is again, the height of the price move prior to the formation of the pennant. Now, how do we make money?

Simply place a buy order above its high point, and never forget the stop order, in this case placed at the low of the pennant. If the market was trying to make a sucker of you, and instead of taking off it broke down, your stop loss would minimize losses.

Trading with Bearish Pennant Breakout

A bearish pennant is formed after a long and sustained decline, with sellers still in control. But sellers from higher levels may square up their positions, causing some buying but this is gradually overcome by the magnitude of fresh sellers. This interplay causes the formation of the pennant. Once the fresh selling overcomes the short-covering, prices again break to the downside and continue the previous bearish trend.

Once prices break down from the pennant they tend to move down by the same margin as the height of the price move prior to the formation of the pattern. The best way to trade a pennant is to sell just below its low point, keeping a stop loss positioned at its highest point.

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